This blog is a commentary on contemporary business, politics, economics, society, and culture, based on the values of Reason, Rational Self-Interest, and Laissez-Faire Capitalism. Its intellectual foundations are Ayn Rand's philosophy of Objectivism and the theory of the Austrian and British Classical schools of economics as expressed in the writings of Mises, Böhm-Bawerk, Menger, Ricardo, Smith, James and John Stuart Mill, Bastiat, and Hazlitt, and in my own writings.

Tuesday, August 22, 2006

More from Böhm-Bawerk on Cost of Production as a Determinant of Prices

The following adds to my previous post about what Böhm-Bawerk says concerning the explanatory role of cost of production in Austrian economics. The quotation is from his essay “Value, Cost, and Marginal Utility,” (trans. George Reisman, Quarterly Journal of Austrian Economics, vol. 5, no. 3, pp. 43-44).

[I]n order to rule out every doubt and every misunderstanding, I want to make a few explicit declarations:

(1) We too [i.e., we “marginal-value theorists,” as he describes his school, i.e., we Austrian economists—GR] fully recognize the sway of a “law of costs” for goods that are reproducible at will. “There is a law of costs”—I once wrote—“costs exercise an important influence on the value of goods.”[18] “That costs of production of goods exercise an important influence on their value is a fact so well verified by experience that it absolutely cannot be doubted.”[19] “One is in fact correct, when one says that costs govern value.”[20]

(2) We too recognize the necessity of “supplementing” the universal law of marginal utility by means of special provisions that relate to the value of goods reproducible at will and that the substance of these is precisely the law of costs. And we have accomplished this "supplementing” in full detail, both for the field of subjective value and for that of objective value and prices.[21]

(3) We too understand the law of costs in such a way that we ascribe to the height of the costs of production, that is to say, to the value of the means of production, the status of a cause—though, to be sure only an intermediate cause—in relation to the value of those products to which the law of costs generally applies. “In our present case (that of goods reproducible at will and of higher direct marginal utility), the value of the product must accommodate itself” (to the value of the means of production). “The value of products of higher direct marginal utility. . . comes to them from the side of the means of production.”[22]

(4) In connection with this, we too acknowledge that changes in the conditions of producing goods reproducible at will never fail to bring about a change in the value of those goods and, to be sure, even without a change in the supply of finished products necessarily having to take place.[23]

[23] Thus, for example, on one occasion, Wieser says: “Cases of the kind last discussed are conspicuous in that the effect of cost on the value of the products takes place without the quantity of products being affected” (Der naturliche Wert [Vienna, 1889], p. 171; [Natural Value (1893; New York: Kelley and Millman, 1956), p. 178. (In the QJAE, Natural Value is mistakenly rendered Natural Law.)])

The above footnote references to Grundzüge can now be found in an English-language translation of that volume. The translation is titled Basic Principles of Economic Value, trans. Hans Sennholz (Grove City, Pennsylvania: Libertarian Press, 2005). The footnote references are to pp. 79, 67, 77, 67-80, 161-167, and 76-77, respectively. There are some generally minor differences between my translation of the sentences quoted by Böhm-Bawerk and their translation by Prof. Sennholz.

I consider it extremely unfortunate that neither Rothbard nor Mises explicitly deals with this very important aspect of Böhm-Bawerk’s writings, which I consider to be one of his major contributions to economic thought. Its inclusion, in my judgment, would have considerably enriched their discussions of prices. Mises did, however, implicitly endorse Böhm-Bawerk’s views on the subject when, immediately after singling out the latter’s Capital and Interest, he wrote: “These masterful expositions are unsatisfactory in some minor points and disfigured by unsuitable expressions. But they are essentially irrefutable. As far as they need to be amended, it must be done by a consistent elaboration of the fundamental thoughts of their authors rather than by a refutation of their reasoning.” [Human Action, 3d ed. rev. (Chicago: Henry Regnery Company, 1966), p. 201.]

Böhm-Bawerk’s treatment of cost and its relationship to marginal utility and price is a very prominent feature of Capital and Interest: it occupies the whole of two chapters in Book III of Volume II, which is titled “Value and Price,” namely, Chapter VII of Part A and Chapter IV of Part B; it also occupies the whole of Excursus VIII in Volume III. Mises must certainly have meant to include this material in his endorsement; it certainly could not be described as “minor points” or “unsuitable expressions.”Beyond this, I was in the fortunate position of learning more of Mises’s views on the subject of the role cost and of his endorsement of Böhm-Bawerk’s views on the subject, as the result of being a member of his seminar at NYU. This made it possible for me to ask him direct questions on the subject. Specifically, I had taken a class from Prof. George Stigler at Columbia University and learned of Dennis Robertson’s attempt to deal with the problem of calculating the marginal product of a tenth hole digger in the face of the availability of only nine shovels. Robertson’s answer, as reported by Stigler, was that the tenth worker could be sent to fetch beer.

I was very dissatisfied with such an answer and began to see serious problems with efforts to derive marginal products and marginal value products from consumers’ goods in many cases. First, I raised the matter with Rothbard, who referred me to various textbooks for the solution. They did not satisfy me any more than had Robertson’s answer. I then raised the matter with Mises. Almost immediately, Mises asked if I had in mind deriving the value of original factors of production or produced factors of production. I replied that I was concerned with both. The value of produced factors of production, he said, was determined by their cost of production.

This was an answer that greatly surprised me. Because until then, I had thought that Mises and all of sound economics totally denied any possibility of value or price being determined by cost. Mises referred me to Capital and Interest for elaboration. The specific reference he gave was to Excursus VII, which is a brilliant essay on the value of complimentary goods and is closely related to Böhm-Bawerk’s views on the subject of costs. Reading it soon led me into the other portions of Böhm-Bawerk’s work that I’ve cited. Mises’s directing me to Böhm-Bawerk on the subjects of imputation and costs, of course, only deepens what for me is the mystery of why he didn’t explicitly incorporate this aspect of Böhm-Bawerk’s writings into Human Action. And as I think back now, a mystery almost as large is why I never thought of asking him.